Worry for Italy Quickly Replaces Relief for Spain

Liz Alderman and Elisabetta Povoledo|The New York Times

Tuesday, 12 Jun 2012 | 4:01 AM ETThe New York Times

SHARES

Concerns grew on Monday that Italy could be the next victim of Europe’s financial infection, leading nervous investors to sell Italian stocks and bonds and damping euphoria over a weekend deal to bail out Spain’s banks.

CNBC

Italian officialsprivately expressed concern that the 100 billion euros, or $125 billion, that Europe pledged to Spanish banks might not stop the troubles from spreading.

Italy’s main stock index was Europe’s worst performer on Monday, a day when United States stocks were also dragged down and investors flocked yet again to the safe harbor of American and German government bonds. Even the Italian prime minister, Mario Monti, a European technocrat who came to office after the euro crisis forced out Silvio Berlusconi last November, has begun to acknowledge the dangers posed to his country’s 1.56-trillion-euro economy ($1.95 trillion).

The main fear is that Italy cannot grow its way out of a recessionfast enough to pay a mountainous national debt. Other concerns include the fact that Italy, with the third-largest euro zone economy after those of Germany and France, will have to shoulder a large portion of the bailout bill even as it grapples with its own sharp economic downturn.

Because Italy does not have enough economic growth to generate the money itself, the government will probably have to borrow it at high interest rates, adding to an already heavy debt load.

“There is a permanent risk of contagion,” Mr. Monti told an economics conference near Venice over the weekend, speaking by telephone. “That is why strengthening the euro zone is of collective interest.”

Prices of Italy’s government bonds reached their lowest level in months. Investors apparently found little assurance that the euro currency union was any closer to solving its underlying problems — not with parliamentary elections in Greecethis weekend that could determine whether the currency union is strong enough to retain its weakest members.

Investor euphoria in Europe over the Spanish bailout deal Monday morning was short-lived, giving way to an essentially flat day on many European stock markets. But Italy’s benchmark index was the Continent’s worst performer, ending down 2.8 percent.

Italian 10-year government bonds dropped in value for a fourth consecutive trading session. The yield— a measure of the government’s borrowing costs and of investors’ perception of risk — climbed 0.26 of a percentage point Monday to just over 6 percent. That is the highest level since January and a level that Italy could not afford for long.

The Spanish government’s 10-year bond yield also rose, closing up 0.30 of a percentage point, to 6.466 percent.

“There’s no doubt contagion will come to Italy,” Daniele Sottile, a managing partner at the financial advisers Vitale & Associati in Milan, said at the same conference, which was convened by the Council for the United States and Italy on an island near Venice. “It’s proof that the European mechanisms designed to stop the crisis are not working.”

Sergio Marchionne, the chief executive of both Fiat and Chrysler, was more blunt at the conference. “Somebody better do something before we get to the point of no return,” he said.

Although Mr. Monti, a former European commissioner, has a reputation as a skilled leader trusted by international officials, he faces a host of problems at home.

Few question Mr. Monti’s competence: Within the first six weeks of coming to power, he managed to pass more economic measures than Italy had in a decade, including increasing the retirement age, raising property taxes, simplifying the operation of government agencies and going after tax evaders. Still pending are economic changes meant to spur growth, including an effort to overhaul Italy’s inflexible labor rules.

But Mr. Monti’s government is also shackled by a legacy of political unwillingness to make painful changes.

As a result, “market attention looks set to shift to Italy,” Commerzbank analysts wrote Monday in a note to clients. Combined with weak growth, they said, the difficulties Mr. Monti faces in getting lawmakers to make economic changes mean “it may be just a matter of time before Italy also seeks help.”

Italy’s dominant political parties, the center-right People of Liberty and the center-left Democratic Party, are participating in Mr. Monti’s government but are averse to being too closely associated with the tough measures he has already put in place and the others he is still pushing for. Some opposition parties have been pressing for new elections to be held before Mr. Monti’s term ends in 2013.

Since Mr. Monti came to power, the Italian economy — like most of those in Europe — has grown weaker. It is expected to contract 1.5 percent this year and increase just 0.5 percent in 2013. Italian banks have sharply curtailed lending, pushing thousands of small and midsize Italian businesses into bankruptcy.

Its government debt, already at 120 percent of gross domestic product (GDP) , will almost certainly continue to rise, especially if Italy must pay a larger portion of the bill for shoring up the monetary union. In many respects, Italy is still better off than Spain and the three other bailout recipients — Greece, Ireland and Portugal . Its annual budget deficit has shrunk to 2.8 percent of GDP, which is down from 4.2 percent a year earlier and below the 3 percent level required by the euro union.

Italy has Europe’s second-largest manufacturing and industrial base, after Germany’s, and is one of the biggest export-oriented economies in the euro zone. “Made in Italy” is still a valuable brand the world over, led by icons like Ferrari cars, Gucci handbags and Ducati motorcycles. The country is also filled with state-owned assets like power companies and the national postal service that could bring in billions of euros should the government manage to privatize them.

Despite recent downgradesby the ratings agency Moody’s Investors Service, Italian banks are relatively sound — at least compared with Spain’s — because they are not saddled with bad debts from a real estate bubble. And even though the Italian government issues more bonds than any other euro zone country, the Italian public owns about half that debt, meaning banks are less vulnerable to fluctuations in the bonds’ value than banks in Spain, which are heavily invested in their government’s risky bonds.

Italy: Next Big Worry?

CNBC's Bob Pisani, John Carney and Sue Herera discuss whether Italy is the next shoe to drop in the European debt mess.

Even so, deposits have been fleeing Italian banks for havens in Switzerland, according to several bankers at the weekend conference, on concern that Mr. Monti will raise taxes for the wealthy and as a hedge if the euro zone economy takes a turn for the worst.

Contagion is as much about fear as economic fundamentals, which is why if Mr. Monti cannot muster the political backing soon to push through his changes, there is a widespread assumption that the crisis will quickly breach Italy’s borders.

“Monti has a good agenda, and has clear in his mind what should be done for Italy,” said Cinzia Alcidi, a research fellow at the Center for European Policy Studies in Brussels. But his approach is that of a technocrat, “and when it is confronted with political and social reality, that makes things more difficult.”

Across Italy’s political spectrum, support for Mr. Monti has been tepid. But many observers agree that any attempt to hold early elections would be disastrous, blocking Mr. Monti’s efforts at change and thrusting Italy back into political mayhem. It is unlikely that any other party or coalition would receive enough support to govern comfortably.

“The good news” said Sergio Fabbrini, director of the school of government at Luiss Guido Carli University in Rome, is that Italy has veered away from becoming a “failed state in Europe” because of Mr. Monti.

The bad news, he said, is that Italy’s embedded politicians have still not acknowledged the reasons for Italy’s problems. “And when the quality of the political elite is as low as it is in Italy, or in Greece, it is difficult to create the structural conditions for growth.”